Recap 2012: IT-ITeS margins remain flat, but PEs eyeing BPO space

The year gone by has been a mixed bag for the $72 billion Indian IT & ITeS sector, with the growth rate skidding in tune with continued slowdown in the key markets of the US and Europe. On the flip side, there are indications of revival in private equity interest in the BPO space, which was earlier considered too mature to offer fresh opportunities.

But as the VCCircle recap of the year shows, there were quite a few important shifts including changes in the pecking order of the top IT firms as long-time bellwethers lose wind. Here’s a quick look at top five trends spotted in 2012, which also throw open various possibilities for the coming year.

Deal-making: Infosys opens purse strings; PEs show interest in BPO space

The past 12 months saw two major deals in the sector as top tier IT services firm Infosys made its largest acquisition till date and bought Lodestone for $350 million while buyout major Bain Capital teamed up with Singapore’s sovereign wealth fund GIC to acquire a large minority stake in Genpact in a $1 billion deal. While the overall count and value of M&A deals in IT software & services sector shrank in 2012, compared to the previous year, private investments (including angel funding, as well as venture capital and private equity investments) got a leg-up this year. However, the private investment trend in overall IT sector was skewed by a bulge bracket Bain-Genpact deal and a flood of angel investments in tech startups. Excluding the Genpact deal, the overall value of private investments in the IT sector almost halved to just $1.5 billion.

Infosys’ acquisition of Lodestone, the largest M&A deal in the IT space in three years, could not prop up the strategic acquisition tally, which shrank by two-thirds in value and almost 20 per cent by volumes, as per data compiled by VCCEdge, the data research platform of VCCircle.

Still, Bain Capital’s big ticket deal in NYSE-listed Genpact showed PE appetite for large ITeS firms. “The BPO sector has seen its ups and downs in terms of love that PE firms have for it. But PE firms are now again showing interest in the sector,” says Rohit Kapoor, CEO, EXL Service, which saw its long-term PE investor Oak Hill make a dream exit from the US-listed firm. Oak Hill also figured among the sellers, along with General Atlantic, in the Bain-Genpact deal.

IT contracts and average contract value shrink

The global slowdown had a direct impact on the contracts that Indian IT firms used to bag from key markets like the US and Europe. In the quarter ended in September 2012, only 380 deals were signed, compared to 472 deals in the same period last year, according to data collated by the consultancy firm, Everest Consulting Group. Of the total, around three-fourth happened to be IT outsourcing deals and the rest largely included BPO contracts, with the IT-BPO bundled offering forming a small minority.

The average contract value (ACV) also registered a significant slide, declining 33 per cent on a year-on-year basis. The reported average deal value for the quarter ended September 2012 was $1.5 million, compared to $2.7 million in the same period last year, said Everest, referring to only deals with disclosed value. Salil Dani, research director of Everest Consulting Group, also mentioned that the overall deal transactions decreased as there were fewer public sector deals and the macroeconomic conditions were not favourable either.

IT margins remain flat

Indian IT companies are not able to leverage higher margins like IBM and Accenture, as they still depend on people to drive higher revenues and are not acquiring the appropriate platforms, feels H Karthik, vice-president (research) at Everest Consulting. Margins for leading Indian IT companies (TCS, Infosys, HCL Technologies and Wipro) declined sequentially by 80 bps, from 25 per cent in Q2 2012 to 24.2 per cent in Q3 2012. But on a year-on-year comparison, margins remained flat.

New verticals emerge but core sectors remain the key; North America still dominates

Banking, financial services and insurance (BFSI) remained the biggest chunk of business for Indian IT companies, accounting for a fifth of the total. The core verticals for the sector still remain BFSI, telecom, manufacturing, retail and energy/utilities. Globally, new verticals like travel and transport, media, education and entertainment together contributed to a quarter of the IT market in 2012, up from 21 per cent in 2011.

“In the coming years, we can expect verticals like healthcare gain more traction because of the US healthcare reforms. Even media, mobile and entertainment will see traction. These verticals usually offer low-value deals but they are emerging businesses,” added Karthik of Everest Consulting.

There was hardly any change in the geographical split of revenues that Indian IT companies get from the global markets, with the US dominating the pack. This is even as the US accounts for just a third of the total for the global IT industry, which declined marginally from 2011. For Indian IT players, North America, as a market, provides more than half the business.

Changes in pecking order

Cognizant, once again, made its mark in the top deck of IT firms. Although headquartered in the US, the firm largely operates from India with three-fourth of its 1.5 lakh-plus employees based in the country. In the third quarter of 2012, it pipped Infosys in terms of dollar revenues to become the second largest IT services firm behind TCS. Last year, it had overtaken Wipro. Given the strong performance by Cognizant, it may trump Infosys for the full fiscal, even as both the firms currently have same revenue guidance of $7.34 billion (although Cognizant expects a growth of 20 per cent for the year ending December 31, 2012, while Infosys has factored in 5 per cent growth for the 12 months to March 31, 2013).

This paints a poor picture for two of the top three biggies in Indian IT. Part of Cognizant’s success is attributed to its headquarters being located in the US. Due to the multi-geographic advantage, it is able to leverage the low-cost benefits provided by Indian employees and still brands itself as an American company while pitching for contracts in the US. Besides BFSI, the company also focuses on newer offerings like social media and mobile analytics, verticals which are still being explored by Indian IT companies.

(Edited by Sanghamitra Mandal)

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